INTRODUCTION TO MONEY LAUNDERING

AND HAWALA TRANSACTION

India’s promising position as a financial centre and its system of informal cross border
money flows makes the country’s susceptibility to money laundering. Some frequent
sources of illegitimate earnings in India are narcotics trafficking, corruption, income tax
evasion etc. Combating money laundering is the most important task for the financial
sector. For India, to diminish informal money transfer channels, it needs to fortify
enforcement around the important areas - responsibility of management in Anti Money
Laundering (AML) policies, scrutinizing of AML systems, adoption of appropriate
‘Know Your Customer’ norms, transaction monitoring, staff training towards regulation
compliance.

MONEY LAUNDERING – BACK TO BASICS

Money Laundering is a highly sophisticated act to cover up or camouflage the identity/
origin of illegally obtained earnings so that they appear to have derived from lawful
sources. It is the process by which illegal funds and assets are converted into legitimate
funds and assets. In other words, it is the process used by criminals to wash their
“tainted” money to make it “clean.”

The term money laundering is generally believed to have derived from mafia ownership
of Laundromats in the United States (US). Gangsters in the US had been earning huge
cash through extortion, prostitution, gambling, bootlegging liquor, etc. In the past, the
term "money laundering" was referred only to financial transactions related to
organized crime. Today its definition is often expanded by Government regulators (such
as the United States Office of the Comptroller of the Currency) to encompass any
financial transaction which generates an asset or a value as the result of an illegal act.

Money laundering generally refers to earnings or profits generated from:

• Movement of drug money/ drug trafficking
• Financial scandals
• Arms, antique, gold smuggling
• Corruption
• Prostitution rings
• Illegal sale of wild life products
• Avoidance of legitimate tax and false accounting practices
• Money transfer through a complex network of shell companies and trusts based in
offshore tax havens
• Diversion of funds from a legitimate destination and use at another destination, etc.
Several regulatory and governmental authorities cite figures for estimated amounts of
money laundered annually, either worldwide or within a national economy. International
Monetary Fund’s estimated that the aggregate of money laundering in the world could be
approximately 2-3% of world’s gross domestic product (GDP) or US$ 500 billion- 1.5
trillion. International consultant, KPMG has estimated that money laundering flows into
India are reported to be in excess of US$ 1 trillion every year by drug dealers, arms
traffickers and other criminals. According to Indian observers, fund transferred through
the hawala/ alternative remittance system are equal to between 30 to 40% of the formal
market. The RBI estimated that remittances to India amounted to US$ 28.2 billion.
Money Laundering not only economically weaken a country but also exposes to terrorist
attacks, threatening its integrity and sovereignty. All over the world, banks have become
more susceptible to Money Laundering activities and financial felony. The largest portion
of laundered funds is processed through banks. This is largely due to the fact that
banks are often the first stop in a multi-tiered laundering scheme. Investment firms,
including brokerages, mutual fund companies and hedge funds also see a significant
amount of activity, attracting more than 25% of money laundering activity. Schemes
targeting insurance companies are a growth sector, now accounting for close to 10% of
activity. A plethora of products and services are offered by the banks and financial
services sector is used to mask the original source of money. With their articulate and
refined manners, Money Launderers attempt to make banks/ investment firms lessen their
protocol so as to accomplish their goal. The quandary of the bank/ investment firms here
in the context of Money Laundering is to sort through the banking activities representing
lawful business and suspicious transactions. This reflects the vulnerability of the
financial institutions to Money Laundering and thus urges the necessity of powerful
regulatory framework to control these illicit acts.

PROCESS OF MONEY LAUNDERING

Money laundering is the masquerading the funds derived from illicit activity so that
the funds may be utilize without revealing of their illegal origin. Money laundering is a
well-thought out process accomplished but not restricted to the following three stages:

1. Placement:

In this process, the launder injects illegal funds or assets into the financial system. It
requires physically placing the funds into legitimate financial institutions. Depositing
structured amounts of cash into the banks, and smuggling currency across international
borders for further deposit, are common methods for placement.

2. Layering:

Once the illegitimate funds have entered the financial system, multiple and complex
financial transactions are conducted to further conceal their illegal nature. Layering
usually involves use of multiple accounts, banks, intermediaries, corporations, trusts,
countries to disguise the origin. Wire transfers between different accounts, purchasing
monetary instruments (traveler’s checks, banks drafts, money orders, letters of credit,
securities, bonds, etc.) with other monetary instruments and changing denominated
currencies facilitate layering.
3. Integration:

Laundered funds are made available as apparently legitimate funds. It involves the
reinsertion of the laundered earnings back into the economy in such a way that they
re-enter the financial system as usual business money/ resources. This may involve a final
bank transfer into the account of a local business in which the launderer is investing in
exchange for a slice in profits.

METHODS OF MONEY LAUNDERING

1. Use of Business entities:

Criminals frequently use business enterprises to launder money. These business

enterprises can be sole proprietorships or business trusts and partnerships or close
corporations and companies. Shell companies are normally used to open and operate
bank accounts. These entities will not actually be trading and their main function would
be to provide the criminal with a corporate veil under which he could conceal his identity.
The shareholders, directors or members of these shell corporations are often family
members. The income of crime is simply blended with the legal proceeds of the business
and deposited into the bank account as the earnings of the business.
Another example is, an information technology company which had many call centers
placed all over the country. The company would call residents of a foreign country and
propose access to credit facility for a fee. The money collected as fees were then
movedcompanies have no corporeal existence in the jurisdiction where they are
incorporated and can be used as an instrument for moving and masking the sources
of funds.

A few of these shell companies, which have the same postal address, appear to be crucial
in the money laundering scheme. On receiving money from the information technology
company in the form of electronic funds transfers, the shell companies then transfer the
funds to an offshore bank account. According to the International Monetary Fund,
‘major offshore centers’ include the Bahamas, Bahrain, the Cayman Islands,
HongKong, Antilles, Panama and Singapore.

2. Residential Real Estate:

Residential real estate-related money laundering is usually linked with mortgage loan
fraud as money launderers may engage in mortgage loan scam to facilitate
laundering through residential real estate. This scam involves a fraudster and a
launderer. Once a fraudulent mortgage loan is funded, the actions of the fraudster and
those of the launderer deviate. The fraudster, who has appointed a deceitful appraiser to
increase the worth of the property and thus the face amount of the loan sanctioned by the
housing finance institution, takes the loan amount and run away. In this case, the
launderer will strive to project an image of normalcy by continuing to make regular and
timely payments on the mortgage loan, thereby integrating his illicit funds. Eventually,
the launderer may re-sell the property, allowing for a trade-up to a more costly property
affording greater laundering and investment prospective. Mortgage loan fraud by using
money laundering includes the purchase and
rehabilitation of distressed property, which is then resold at a price greater than the
original price, inflation of the fair market value of property by appointing a spurious

evaluator. This counterfeit appraisal is proposed to convince housing finance institution

to grant a mortgage loan on the property for more than the property value. The lending
institution may suffer a loss if the loan goes unpaid, and may be left with a foreclosed
property that has a market value below the fake appraisal value. Launderers may use
several nominees to secure numerous mortgages on diverse residential properties,
thereby forming a means for the exchange of illicit cash into real property while
showcasing the manifestation of many unconnected mortgages paid on a normal and
timely basis.
3. Insurance Policies:

A director of a Company A, set up a money laundering scheme concerning two

companies, each one incorporated under two different jurisdictions. Both the
companies used to provide financial services and providing financial guarantees for
which he would act as director. These companies wired the sum of US$ 5 million to
the accounts of the company director in Country M. It is likely that the funds derived
from some kind of criminal activity and had already been injected into the financial
system. The company director also received transfers from Country N. Funds were
moved from one account to another by making use of several bank accounts. Through
one of these transfers, the funds were transferred to Country P from a current account in
order to make payments on life insurance policies. The investment in these policies was
the main device in the money laundering scheme. The premiums paid for the
lifeinsurance policies in Country P amounted to some US$ 5.5 million and signified the
final
step in the money laundering.
An effort was made to buy life insurance policies for several foreign nationals. The
underwriter was asked to offer life coverage with an indemnity value equal to the
premium. There were also signals that if the policies were to be withdrawn, the return
premiums were to be paid into a bank account in a different jurisdiction to the assured.
The funds were deposited into several bank accounts and then transferred to an account in
another jurisdiction. The money launderer then entered into a US$ 1 million life
insurance policy. Payment for the policy was made by two separate wire transfers from
the overseas accounts. It was purported that the funds used for payment were the
proceeds of overseas investments.

4. Use of Financial Institutions:

India has a robust financial system. Products and services on offer vary from internet/
mobile banking facilities and off-shore investments to small savings accounts. These
financial instruments facilitate depositing a sizable chunk of dirty money into bank
accounts. Launderers often open accounts with false credentials or will open it in the
names of companies or trusts. There is also a tendency of using valid bank accounts of
family members or third parties with prior arrangement. In subsequent investigations, the
family member will perpetually beg lack of knowledge of the true nature of deposited
funds. Bearer documents such as Negotiable Certificates of Deposit have also been
employed in sophisticated schemes.

5. Structuring Deposits/ Smurfing:

This method involves segregation of huge sums of money into smaller, less-suspicious
amounts. In the United States, this smaller amount has to be below US $10,000 - the
dollar amount at which U.S. banks have to report the transaction to the government. The
money is then deposited into one or more bank accounts either by multiple people or by a
single person over an extended period of time.

6. Fraudulent Investment Schemes:

The case comprises many companies – some of them were trading companies - and
related individuals that were alleged for asking for funds with the assurance of high
returns on investments.
Presume there is an existing BSE-listed company, which is closed and is not trading at
all. Today, there are over 8,000 companies listed on the BSE, of which more than 50%
companies are in the B2 and Z category and are hardly traded. It can happen that two
or three people form an alliance and take over such a company changing its name to an
infotech company. It is even probable that the existing promoters of the company simply
change the name of their company to a software company. In actual practice, these
companies do not even be having the necessary infrastructure or the requisite workforce
essential to run a software company. The next step is to form a subsidiary overseas by
renting a place or just even employing a person to carry out the operations. Most of
theexports are made to duty free ports such as Hong Kong, Singapore or Dubai
where
the money can be remitted back.

After that, the promoters conduct Hawala/ alternate remittance transactions by paying
cash over here and getting dollars from abroad through the subsidiary. The same dollars
transferred from abroad are shown as software exports in the company's books. In this
way the company is able to report decent sales figures in its balance sheet by the way of
export income. The next step is to grab a flashy share broker or market operator
whose gossips about the company can be floated in the market. The share broker
orthe operator then spreads stories such as the company has got big software
development
orders or tie-ups and is going to post superb profit numbers. Obviously, the fake export
income compels the net profit stating strong Earnings per Share for the company.
Since, the P/E of the company appears to be quite low in comparison with the
industry P/E; the stock appears to be an excellent buy.
The market operators start providing liquidity in the counter by creating demand
for the stock by them. As a result the volumes in the counter start increasing. The stock
price of the company starts touching upper circuits in sequence. The promoters start
taking advantage of this situation by reducing their own stake and offering it to the small
investors who will be willing to buy. In the end we have the small investors who are left
holding the stock which they have purchased at the high prices. Thus the promoters
areable to take advantage in two ways. Firstly they are able to get a superior price for
the
dead stocks of their company, which were not being traded at all and secondly are
able to exchange their cash into official export income at a low premium without
paying any income tax. However, the query which authority is accountable to make sure
whether the companies
are actually occupied in and whether their exports are authentic or not? This is necessary
so that the investors can be more cautious about such companies before investing their
hard-earned money into them.
Ultimately, the technology can be boon or bane depending on its end-user. MONEY

LAUNDERING CASE-STUDY - HAWALA

The Economic Times (March 16, 2005) reported a case of money laundering in the year
1999-2000 when about Rs. 700 crore made its way from the Gulf, through the hawala
route to accounts in bank branches in Mumbai; the money was then diverted to Kerala for
large investments in real estate.
In earlier times, informal fund transfer systems were used for trade financing. They
were created because of the dangers of traveling with gold and other forms of payment on
routes beleaguered with robbers. Local systems were widely used in China and other
parts of East Asia and continue to be in use there. They go under various names -
Fei-Ch'ien (China), Padala (Philippines), Hundi (India), Hui Kuan (Hong Kong),
and Phei Kwan (Thailand). The hawala (or hundi) system now enjoys widespread use
but is historically associated with South Asia and the Middle East. At present, its primary
users are members of expatriate communities who migrated to Europe, the Persian Gulf
region, and North America and send remittances to their relatives on the Indian
subcontinent, East Asia, Africa, Eastern Europe, and elsewhere. These emigrant workers
have reinvigorated the system's role and importance. While hawala is used for the

legitimate transfer of funds, its anonymity and minimal documentation have also made it
vulnerable to abuse by individuals and groups transferring funds to finance illegal
activities.
At present, many of these so-called software companies were known to be exercising the
Hawala route in order to illustrate income from software exports. Hawala (also referred
to as hundi) substitute remittance scheme. In other words, it is money transfer without
movement. Hawala is old systems began in South Asia; today it is used around the world
to carry out lawful remittances. Let us see how hawala can, and does, play a role in
money laundering. Hawala functions outside of conventional banking system. What
discriminates Hawala from other remittance systems are conviction and the widespread
networking. Let us see how hawala transfer takes place.
Mr. X is a national of country Y residing in country Z. He entered the country on a tourist
visa, which has long since expired. He wants to send US$ 10,000 to his family residing in
country Y. If he goes by normal banking channels, he has to open the account with bank
which again involves all documentation formalities.
A hawala person – Mr. A offers him the following deal:
A 5% 'commission' for handling the transaction; higher conversion rate for dollar
(For example if the official rate is 1 US$ = Rs. 45; Hawala person can offer you at 1 US$
= Rs. 50) and the currency in which he wants to convert including delivery charges. The
money transfer related with a hawala transaction is faster and more reliable than in
bank transactions.

Mr. X decides to a deal with a hawala person Mr. A. The hawala transaction proceeds as
follows:
Mr. X gives the US$ 10,000 to Mr. A; Mr. A contacts Mr. B in country Y, and gives him
the details; Mr. B arranges to have the money (by taking into consideration conversion
rate described above) delivered to the family of Mr. X.
Even though this is a simple example, it contains the elements of a hawala transaction.
First, there is trust between Mr. X and Mr. A. This money transfer nearly takes place
within a day of the initial payment (a consideration here is time differences) and the
payment is always made in person. Hawala dealers are almost always honest in their
dealings with customers and fellow hawaladars. Breaches of trust are extremely rare. It is
worth noting that one of the meanings attached to the word hawala is 'trust'!
Connections are of equal significance. Hawala networks tend to be slack,
communication usually takes place by phone or fax or email. These associations allow for
the organization of a complex network for performing the hawala transactions. Since
many hawala transactions are conducted in the context of import/ export businesses, the
manipulation of invoices is very common methods of settling accounts after the
transactions have been made. When compared to a 'traditional' means of remitting
money, such as obtaining a check or ordering a wire transfer, hawala seems
cumbersome and risky.

A few other benefits that hawala transaction offers are:

1. Cost Efficiency –

Some of the reasons for this cost efficiency, namely low overhead, exchange rate
manipulation and integration with existing business activities.
In India, for example, the Foreign Exchange Regulation Act (FERA), 8(2) states that
'except with the previous general or special percussion of the Reserve Bank, no person,
whether an authorised dealer or a moneychanger or otherwise, shall enter into any
transaction which provides for the conversion of Indian currency into foreign currency
or
foreign currency into Indian currency at rates of exchange other than the rates for time
being authorised by the Reserve Bank'.
Since hawala dealers do not, in many if not most cases comply with such regulations,
their transactions may be illegal. Hawala persons exploit naturally occurring currency
fluctuations in the demand for different currencies. This enables them to turn a profit
from hawala transactions and they are also able to offer their customers rates that are
better than those offered by banks. In brief, hawala competes efficiently with other
remittance instruments - because of its cost effectiveness.
2. Speed of the Transaction -

A hawala remittance takes place in, at most, one or two days. This can be contrasted
with the week or so required for an international wire transfer involving at least one
correspondent bank.

3. Lack of administration –

Mr. X is living and working in the country Z on an expired visa. Since hawala is a
remittance system, this question really addresses jurisdiction governing remittance
services. Even though hawala is illegal from a regulatory standpoint in some
jurisdictions, hawaladars advertise their services widely in a variety of media.
Enforcement of these regulations is complicated with respect to hawala.
In spite of the existence of these regulations is another reason hawala is still used. Many
people in these countries have money that they would like to move to another country.
Hawala provides a means of doing this, and its use as a catalyst of 'capital flight' on
both large and small scales is very common.

4. Tax evasion –

In South Asia, the 'black' or parallel economy is 30%-50% of the 'white' economy.
Money remitted through official channels may invite scrutiny from tax authorities -
hawala provides a scrutiny-free remittance channel.
Another aspect of these regulations is the use of the United Arab Emirates, specifically
Dubai, for hawala transactions. There are two main reasons for this. The first is the large
population of expatriate workers from India and Pakistan; they use hawala to send
money home. The second is Dubai's large gold market, which is the source of much of
the gold sent (licitly and illicitly) to India and Pakistan. Dubai, unlike many other South
Asian nations, allows essentially unregulated financial dealings. Because of this, many
South Asian businessmen maintain offices in Dubai, and money is often wired there to

circumvent regulations elsewhere. In addition, Dubai offers a neutral meeting place for
Indian and Pakistani businessmen, as tension between these countries makes travel
between them difficult if not impossible.

5. Trustworthiness -

Intricate overseas transactions, which might engage the client's local bank, its
correspondent bank, the main office of a foreign bank and a branch office of the
recipient's foreign bank, have the potential to be problematic. However, the hawala
network person can complete the transaction in less than a day.
Hawala can provide an efficient means of placement. In the example, Mr. X gave Mr. A
US$ 10,000 in cash. Since Mr. A also operates a business, he will make periodic bank
deposits consisting of cash and checks. He will validate these deposits to bank officials as
the income from his legal business. He may also use some of the cash received to meet
business expenses, reducing his need to deposit that cash into his bank account.
Hawala transfers leave a mystifying paper track. Even though invoice manipulation is
used, the mixture of legal goods and illegal money, confusion about `valid' prices and a
possibly complex international shipping network create a trace much more convoluted
than a plain wire transfer.
The same distinctiveness of hawala that make it a possible means for the layering of
money also make it ideal for the integration of money. This is when money seems to
become legitimate and hawala techniques are proficient in transforming money into any
form, offering numerous possibilities for establishing a manifestation of authenticity.

The money transferred through hawala means can be 'reinvested' in a legitimate (or
legitimate appearing) business. Hawala is actually quite simple; much of the density
associated with hawala comes from the immeasurable number of deviations that are seen
in hawala transactions.
This complexity of variation makes it unfeasible to lay out a clear-cut guide to identify
hawala as part of a criminal undertaking. It is, however, possible to provide a few
pointers that may be useful.
One of the most official indicators of hawala transaction in investigations conducted in
bank accounts. A 'hawala' bank account shows noteworthy deposit activity, usually in
the forms of cash and checks, which are often from one or more ethnic communities (e.g.
Afghan, Bangladeshi, Indian, Pakistani, Somali). These checks may also have some kind
of details, consisting of a name or something supposedly indicating what was 'bought'
with the money. These accounts will also illustrate outgoing wire transfers to a major
financial center. Given the flexible characteristic of the hawala business, hawala
accounts will not always be seen to balance. Laws in India, Pakistan and other countries
make it tricky to convert foreign currency. Unlawful activities in these countries may
often involve foreign currency, which pose something of a problem.

Hawala cases:

1. Terrorism:

The series of bomb blasts in a major Indian city in 1993 was funded through hawala. The
investigation exposed that the funds behind these bombings were routed through hawala
operators in the United Kingdom, Dubai and India.

2. Insider Trading:

A citizen of a South Asian country, who was an investment banker in a major financial
center, is accused of giving 'tips' to various friends and relatives. After some illegal trades
took place, the banker resigned and apparently fled the United States for his homeland.
At the same time, several of his associates also traveled to this same country as well as
several European financial centers. An examination of detained bank records reflects that
money was transferred to persons having the same nationality in at least one of these
financial centers. It is possible that these wire transfers were the first part of hawala-like
transfers of the profits from the illegal trades to the investment banker's home country.
3. Narcotics Trafficking:

Citizens of some countries supposedly importing heroin and are alleged of shaking hands
with bank officer to clean the earnings from the sale of the heroin. This bank officer is
understood to open accounts without following proper 'know your customer' (KYC)
norms and also assists the traffickers with the management of these accounts, which are
used for illegitimate money transfers. In addition, this bank officer may be handling the

receipt of shipments of negotiable instruments from a south Asian country on behalf of

so-called criminals in that country. These shipments may symbolize part of money
laundering scheme as well as probable infringement of country’s laws regarding the
import of currency.

4. Welfare Fraud:

Certain immigrants from a particular country are charged for committing large scale
welfare fraud. An employee of a rental agency deposits large numbers of checks into a
personal checking account, and then wires money to a variety of offshore locations. It is
suspected that hawala is being used to remit money (which probably includes proceeds
derived from welfare fraud), via couriers.

5. Gambling:

Hawala has been used as a substitute banking system in a South Asian gambling
operation. The gambling operators have engaged hawala operators to accept money 'on
deposit' from gamblers, and pay winnings through them as well. This is something of a
indication to the dependability of hawala. One of the principals in this gambling
operation is that this had been going on for nearly twenty years without any major
difficulties.

6. Customs and Tax Violations:

An individual representing himself as being in the gold business in a large city, especially
as a 'gold broker', is alleged of different customs and tax infringements as well as money

laundering. This individual has made very large cash deposits at several banks, and at
least one bank has closed this individual's account because of these deposits. This
individual's bank account was inspected in juxtaposition with a tax investigation. This
individual asserts to provide gold shops with gold bullion, and also that he sells gold
coins and jewellery to individuals. It is believed that this individual is acting as a bank for
various individuals and businesses, supplementing them in escaping the tax payment.
In the wake of the recently sensitive concerns that money launderers and terrorist groups
use informal transfer systems, many countries consider the overlooking of the hawala
industry as no longer a suitable policy alternative. The probable ambiguity that portrays
these systems is believed to present risks of money laundering and terrorist financing and
therefore it is required to provide proper attention to these problems.
MACROECONOMIC EFFECTS ON THE ECONOMY OF THE
COUNTRY

Because crime, underground activity, and money laundering take place on a large scale,
macroeconomic policymakers must take them into account. But, as these monetary
transactions are tough to determine, they deform economic data and make problems in
Governments' efforts to administer economic policy. In addition, the capability to
recognize the country and currency of issuance and the citizenship of deposit holders is
solution in understanding monetary behavior.

Money laundering can have a range of severe macroeconomic consequences on countries.

Some of these consequences are as follows:
• It can cause unpredictable changes in money demand - To the extent that money
demand appears to shift from one country to another because of money laundering -
resulting in ambiguous monetary data.
• It increases the volatility of international capital flows and exchange rates due to
unanticipated cross-border transfers - It will have adverse consequences for interest
and exchange rate volatility, particularly in dollar denominated economies, as the
tracking of monetary aggregates becomes more uncertain.
• It can cause troubles to the reliability of financial institutional framework of the
country and thus taints legal financial transactions.
The income allocation effects of money laundering must also be considered. For
example, there is indication that funds to evade taxes in India tend to be channeled into
riskier but higher-yielding investments in the small business. Money laundering also has
macroeconomic consequences in an indirect manner. Illegitimate transactions can
discourage legal ones by contamination. For example, some transactions concerning
foreign participants, although completely legal, are reported to have become less
attractive because of a relationship with money laundering. Money that is laundered for
reasons other than tax evasion also tends to dodge taxes, compounding economic
distortions. Accumulated balances of laundered assets are likely to be larger than annual
flows, causing impending destabilization and executing cost-effectively inefficient

movements, either cross borders or domestically. These balances could be used to

crook markets or small economies.
The above effects are to some extent exploratory; however, the Quirk study (1996) also
conducted empirical tests on the correlation between GDP growth and money
laundering in 18 industrial countries for the first time. It was found that major reductions
in annual GDP growth rates were coupled with augment in the laundering of criminal
proceeds in the period 1983-90.

ANTI MONEY LAUNDERING LEGISLATION

The trustworthiness of the banking and financial system depends heavily on legal,
professional and ethical skeleton in which it works. As a result the International
organizations and regulators started developing international standards and best practices
to address to money laundering issues in a collaborative manner. Across the world,
banks and financial institutions are required to initiate and execute systems to prevent
anti-social elements from using banking channels for money laundering. Implementation
of apt ‘Know Your Customer measures’ is a vital element of risk management in
banks, in order to protect the confidence and the authenticity of banking systems.

International Scenario with respect to Anti-money Laundering:

• Mid 1980s - Growing concern of international community to deprive criminal
elements of the proceeds of their crimes.
• 1989 – Financial Action Taskforce (FATF) set up to ensure global action to combat
money laundering.
• Forty Recommendations - Complete set of counter-measures against money
laundering.
• Nine Special Recommendations on Terrorist Financing.
• 1995 - Egmont Group set up to stimulate international cooperation amongst Financial
Intelligence Units (FIUs).
• 1997 - Asia Pacific Group on money laundering (APG) set up to create awareness and
encourage adoption of AML measures.
Indian Scenario:
The Prevention of Money Laundering Act, 2002 (PMLA) enacted to prevent money
laundering and provide for confiscation of property derived from, or involved in, money
laundering. The PMLA act was enacted on 17th Jan, 2003. It was brought into force from
1st July, 2005. It is administered by:
• Financial Intelligence Unit (FIU) for verification of identity of clients, maintenance
of records and reporting
• Enforcement Directorate (ED) for investigation of and prosecution for
moneylaundering
offences

Subordinate legislations: Rules under PMLA:

• Various Rules came into effect from July 2005
• Rules detailing Powers of Director FIU and ED
• Rules detailing the method of attachment of property, period of retention etc
• Rules detailing the receipt & management of confiscated assets
• Rules relating to legal obligations of reporting entities
Rules detailing the legal obligations of reporting entities:
Prevention of Money Laundering (Maintenance of Records of the Nature and Value of
Transactions, the Procedure and Manner of Maintaining and Time for Furnishing
Information and Verification and Maintenance of Records of the Identity of the Clients of
the Banking Companies, Financial Institutions and Intermediaries) Rules, 2005
Legal Obligation under PMLA:
PMLA and the Rules impose obligations on - Banking companies, financial institutions,
intermediaries of the securities market – to maintain records, furnish information, and
verify identity of clients.
Reporting entities under PMLA (Section 12):
“Banking Company” under PMLA includes:
• All nationalized banks, private Indian banks and private foreign banks
• All co-operative banks viz. primary co-operative banks, state co-operative banks and
central (district level) co-operative banks
• State Bank of India and its associates and subsidiaries
• Regional Rural Banks

Financial Institution under PMLA includes:

• Financial Institutions as defined in Section 45-I of the RBI Act namely EXIM Bank,
NABARD, NHB, SIDBI, IFCI Ltd., IDFC Ltd., IIBI Ltd. and TFCI Ltd.
• Insurance companies
• Hire Purchase companies
• Chit fund companies as defined in the Chit Funds Act.
• Co-operative banks
• Housing finance institutions as defined in the National Housing Bank Act such as
HDFC.

Non-banking financial companies as defined in section 45-I of the Reserve Bank of

India (RBI) Act such as private finance companies - motor and general finance
companies, leasing companies, investment companies etc.
Intermediary under PMLA includes persons registered under Section 12 of the
Securities and Exchange Board of India (SEBI) Act, 1992:
• Stock brokers
• Sub-brokers
• Share transfer agents
• Bankers to an issue

• Trustees to trust deed

• Registrars to issue
• Merchant bankers
• Underwriters
• Portfolio Managers
• Investment advisers
• Depositories
• Custodian of securities
• Foreign institutional investors
• Credit rating agencies
• Venture capital funds
• Collective investment schemes including mutual funds
Every reporting entity shall communicate the name, designation and address of the
Principal Officer to the Director, FIU-IND. The Principal Officer shall furnish the
following information:
• Furnish the information referred to in the Rules to the authorities
• Retain copy of such information for the purposes of official record

Reporting of Cash Transactions:

• All cash transactions of the value of more than Rs. 10,00,000 or its equivalent in
foreign currency

• All series of cash transactions integrally connected to each other which have been
valued below Rs. 10,00,000 or its equivalent in foreign currency where such series
of transactions have taken place within a month
• Cash Transaction Report should be filed by the 15th day of the succeeding month
Reporting of Suspicious Transactions:
All suspicious transactions whether or not made in cash Suspicious Transactions
Report should be filed with FIU within seven working days of establishment of
suspicion at the level of Principal Officer.
Suspicious transaction means a transaction whether or not made in cash which, to a
person acting in good faith –
• Gives rise to a reasonable ground of suspicion that it may involve the proceeds of
crime; or
• Appears to be made in circumstances of unusual or unjustified complexity; or
• Appears to have no economic rationale or bonafide purpose.
Related obligations - Records containing information for reporting purposes:
• Nature of transaction
• Amount & currency of transaction
• Date of transaction
• Parties to transaction
• Manner as prescribed by the regulators (RBI/ SEBI/ IRDA)

• Maintain & retain reported records for 10 years from cessation of transaction between
client & reporting entities (Rule 6)
• Client identity
• Current and permanent address of client, his nature of business, his financial status
• Maintain records of the identity of clients for a period of 10 years from the date of
cessation of the transactions with the client. (Rule 10)

Legal obligations & guidelines imply:

1. Customer Acceptance -
• Ensure acceptance of only legitimate and bona fide customers
• Issue of mechanism to verify ID
• Issue of Multiple IDs
• Issue of list of suspects/criminals/unwanted elements
• Awareness and training of staff

2. Customer Identification -

• Ensure that the customers are properly identified to understand the risks they may
pose.
• Background check of new customer
• Background check of existing clients
• Issue of List of suspects/criminals/unwanted elements
• Awareness and training of staff
3. KYC & CDD - Transactions Monitoring -

• Monitor customers’ accounts and transactions to prevent or detect illegal activities

• Issue of Mechanism to verify financial details
• Transactions inconsistent with customers profile (business)
• Unexplained transfers between multiple accounts with no rationale
• Sudden activity in dormant accounts

4. Risk Management -

• Implement processes to effectively manage the risks posed by customers trying to

misuse facilities.
• Categorization of customers: high/medium/low risk : a dynamic concept
• Constant interaction between front desk and the compliance team required
• Awareness and training of staff
• Set up processes and technology to identify and report suspicious transactions
• Capture customer details
• Generate alerts
• Collect and analyse additional information
• Decide whether transactions are suspicious
• Ensuring reporting of quality data electronically
• Alignment of people, process and technology
• Confidentiality and Privacy

Recently, a Bill to amend the Prevention of Money Laundering Act was introduced in the
Rajya Sabha by Minister of State for Finance Pawan Kumar Bansal. As per the Bill,
money changers, money transfer service providers such as Western Union and
credit card payment gateways like VISA and MasterCard will now come under the
ambit of India's anti-money laundering laws. After the Amendment Bill is passed by
Parliament and comes into effect, businesses like casinos would also come under legal
obligation to report their activities in the country. For fighting the menace of terrorism,
the Bill introduces new category of offences which have cross-border implications.
The draft legislation also empowers the Enforcement Directorate "to search premises
immediately after the offence is committed". The investigating agency can attach any
property and search a person after completing the probe. It can enhance the period of
provisional attachment of property from 90 days to 150 days.

PREVENTION OF MONEY LAUNDERING -

NEED OF THE HOUR

India is enthusiastic in combating money laundering and terrorist financing. It is taking

progressive steps to execute Anti Money Laundering (AML) programmes in all the
financial institutions. With systems and procedures are in place, let us hope to be one of
the member countries of Financial Action Taskforce (FATF) and unite in the
international efforts to contest money laundering and terrorist financing.
The need of the hour is to organize and reinforce collection and sharing of financial
intelligence through an effective national, regional and global network to battle money
laundering and related crimes. Few areas of compliance have seen the constant level of
activity that has come to characterize anti-money laundering (AML) efforts in recent
years. Money Laundering is a highly complicated and epidemic problem driven by vast
criminal and terrorist networks that requires skill and knowledge to discourage. In order
to guard a firm from the malice money laundering, institutions need AML solutions that
cover all areas of the business and all geographies where the firm conducts business.
In the super-charged rivalry for eating market share, firms just cannot jeopardy the
damage to reputation, client trust and market capitalization that results from financial
abuse and illegitimate activity. India has leading position in information technology, with
the help of this capability India can prepare AML software to provide widespread gamut
of analytical money laundering behaviors.
The developed software can control and demonstrate compliance with the letter and
spirit of regulations. This improves status with regulators and results in less recurrent
shorter audits. The software should have advanced alert generation and workflow
patented analysis techniques which can sense key behaviors of money laundering – for
example relationships between accounts – not obvious to rules or profile-based
applications or, manual analysis. Alerts provide a framework of business statistics and
historical information to rationalize analysis and resolution.
34
The developed software will enable firms to curtail investigation times and improved
risk management with its aptitude to tailor risk and trust weightings for individuals or
entities to put objectively unusual behavior in context of that individual’s or entities
expected behavior. This will assist the firms in time saving, staff costs savings and will
efficiently manages risk by isolating actual unusual behaviors. The software will also
integrate Behavior Detection Platform which will assist in avoiding risk, exceeding
regulatory requirements, and improving customer relationships. It will analyze the
behavior of customers, employees, and partners in every transaction across the enterprise,
from every angle - past, present, and future - empowering companies to act with
meticulousness and buoyancy. This will create precision, escalating firm’s ability to
comprehend business – both risks and opportunities.
Combating money laundering will bring transparency in the system. Transparency
ensures trust. Trust, along with operational excellence, is the key to retaining
customers and growing market share.
Finally, I would like to sum up the entire paper by making use of the vision of India
articulated by Rabindranath Tagore…
“…… Where words come out from the depth of truth
Where tireless striving stretches its arms towards perfection
Where the clear stream of reason has not lost its way
Into the dreary desert sand of dead habit….’
35
This means integrity, honesty and trustworthiness are the essential foundations for a
successful democracy and a prosperous society. Both good governance and commercial
success demand rigorous standards of transparency, accountability and reliability in
word and action. Although we have made progress, money laundering is an impending
threat requiring a dynamic response. As globalization unlock boundaries to travel and
trade, and global payments and clearing systems advance novel money laundering
prospects are created and exploited. Accordingly, Indian Money Laundering Strategy
should responds to established and emerging money laundering trends and modus
operandi both at home and abroad.
Lets us put into practice anti-money laundering methods with the help of which the
threads from Rabindranath’s poem - the vital strands - from which a fulfilling vision of
Dream India can be woven.

Hawala
Hawala (also known as hundi) is an informal value transfer system based on the
performance and honour of a huge network of money brokers, which are primarily
located in the Middle East, North Africa, the Horn of Africa, and South Asia.

Origins

Hawala has its origins in classical Islamic law and is mentioned in texts of Islamic
jurisprudence as early as the 8th century. Hawala itself later influenced the development
of the agency in common law and in civil laws such as the aval in French law and the
avallo in Italian law. The words aval and avallo were themselves derived from Hawala.
The transfer of debt, which was "not permissible under Roman law but became widely
practiced in medieval Europe, especially in commercial transactions", was due to the
large extent of the "trade conducted by the Italian cities with the Muslim world in the
Middle Ages." The agency was also "an institution unknown to Roman law" as no
"individual could conclude a binding contract on behalf of another as his agent." In
Roman law, the "contractor himself was considered the party to the contract and it took a
second contract between the person who acted on behalf of a principal and the latter in
order to transfer the rights and the obligations deriving from the contract to him." On the
other hand, Islamic law and the later common law "had no difficulty in accepting agency
as one of its institutions in the field of contracts and of obligations in general."[1]

Hawala is believed to have arisen in the financing of long-distance trade around the
emerging capital trade centers in the early medieval period. In South Asia, it appears to
have developed into a fully-fledged money market instrument, which was only gradually
replaced by the instruments of the formal banking system in the first half of the 20th
century. Today, hawala is probably used mostly for migrant workers' remittances to their
countries of origin.

How Hawala works

In the most basic variant of the hawala system, money is transferred via a network of
hawala brokers, or hawaladars. A customer approaches a hawala broker in one city and
gives a sum of money to be transferred to a recipient in another, usually foreign, city. The
hawala broker calls another hawala broker in the recipient's city, gives disposition
instructions of the funds (usually minus a small commission), and promises to settle the
debt at a later date.

The unique feature of the system is that no promissory instruments are exchanged
between the hawala brokers; the transaction takes place entirely on the honor system. As
the system does not depend on the legal enforceability of claims, it can operate even in
the absence of a legal and juridical environment. Informal records are produced of
individual transactions, and a running tally of the amount owed by one broker to another
is kept. Settlements of debts between hawala brokers can take a variety of forms[further
explanation needed]
, and need not take the form of direct cash transactions.

In addition to commissions, hawala brokers often earn their profits through bypassing
official exchange rates. Generally, the funds enter the system in the source country's
currency and leave the system in the recipient country's currency. As settlements often
take place without any foreign exchange transactions, they can be made at other than
official exchange rates.

Hawala is attractive to customers because it provides a fast and convenient transfer of

funds, usually with a far lower commission than that charged by banks. Its advantages are
most pronounced when the receiving country applies distortive exchange rate regulations
(as has been the case for many typical receiving countries such as Pakistan or Egypt) or
when the banking system in the receiving country is less complex (e.g. due to differences
in legal environment in places such as Afghanistan, Yemen, Somalia). Moreover, in some
parts of the world it is the only option for legitimate funds transfers, and has even been
used by aid organizations in areas where it is the best-functioning institution.[2]

Furthermore, the transfers are usually informal and not effectively regulated by
governments, which is a major advantage to customers with tax, currency control,
immigration, or other concerns. In some countries however, hawalas are actually
regulated by local governments and hawaladars are licensed to perform their money
brokering services.

Hundis

On a similar note, Hundis referred to legal financial instruments evolved on the Indian
sub-continent. These were used in trade and credit transactions; they were used as
remittance instruments for the purpose of transfer of funds from one place to another. In
the era of bygone kings and the British Raj these Hundis served as Travellers Cheques.
They were also used as credit instruments for borrowing and as bills of exchange for
trade transactions.

Technically, a Hundi is an unconditional order in writing made by a person directing

another to pay a certain sum of money to a person named in the order. Being a part of an
informal system, hundis now have no legal status and were not covered under the
Negotiable Instruments Act, 1881. They were mostly used as cheques by indigenous
bankers.

Angadia
The word angadia means courier (in Hindi) but it is also used for people who act as
Hawaladars within the country (India). These people mostly act as a parallel banking
system for businessmen. They charge a commission of around 0.2-0.5% per transaction
from transferring money from one city to another.

Hawala after September 11, 2001

Hawala has been made illegal in some U.S. states[3] and other countries[citation needed] as it is
seen to be a form of money laundering and can be used to move wealth anonymously. It
continues, however, to be a legal and effective system in many countries across the globe.

After the September 11 terrorist attacks, the American government suspected that some
hawala brokers may have helped terrorist organizations to transfer money to fund their
activities. The 9/11 Commission Report has since confirmed that the bulk of the funds
used to finance the assault were not sent through the hawala system, but rather by inter-
bank wire transfer to a SunTrust Bank in Florida, where two of the conspirators had
opened a personal account. However as a result of intense pressure from the U.S.
authorities, widespread efforts are currently being made to introduce systematic anti-
money laundering initiatives on a global scale, the better to curb the activities of the
financiers of terrorism and those engaged in laundering the profits of drug smuggling.

Whether these initiatives will have the desired effect of curbing such activities has yet to
be seen; although a number of hawala networks have been closed down and a number of
hawaladars have been successfully prosecuted for money laundering, there is little sign
that these actions have brought the authorities any closer to identifying and arresting a
significant number of terrorists or drug smugglers.[4] Experts emphasize, though, that the
overwhelming majority of those who use these informal networks are doing so for
legitimate purposes.[2]

In November 2001, the Bush administration froze the assets of Al-Barakat, a Somali
remittance hawala company used primarily by the large Somali diaspora. Many of its
agents in several countries were initially arrested, though later freed after no concrete
evidence against them was found. In August 2006 the last Al-Barakat representatives
were taken off the U.S. terror list, though some assets remain frozen.[5] In October 2009,
the Swedish branch of Al-Barakat was removed from the United Nations' list of terrorist
organizations; the company had been on the list for the past eight years, and had had its
bank account funds frozen. According to the Swedish Public Radio broadcaster SR, the
UN did not explain why it had elected to remove Al-Barakat from its terror list. However,
it has been suggested that the recent change in the European Union's position regarding
the many organizations "that have been too easily included in the UN terror list" might
have influenced the UN's position. Al-Barakat is now able again to access its bank
account funds.[6]
Media has been speculating that Somali pirates use the hawala system to move funds
internationally, for example into neighboring Kenya, where corruption is high and these
transactions are neither taxed nor recorded.[7]

The 2010 court case United States v. Banki dealt with the question of whether hawala
transactions violated the current U.S. sanctions against trade with Iran.

In January 2010, the Kabul office of New Ansari Exchange, Afghanistan's largest hawala
money transfer business, was shuttered following a raid by the Sensitive Investigative
Unit, the country's national anti-graft task force vetted and trained by the US Drug
Enforcement Administration (DEA), allegedly because this company could be involved
in laundering profits from the illicit opium trade and moving the cash earned by Taliban
through extortion and drug trafficking. Thousands of records were seized to dig into the
movement of billions of dollars in and out of Afghanistan. There were links between the
money transfers by this company and political and business figures in the country,
including relatives of President Hamid Karzai. In August 2010, Karzai took control of the
taskforce that staged the raid, and another US-advised anti-corruption group, the Major
Crimes Task Force. He ordered a commission to review scores of past and current anti-
corruption inquests. Senior US military and civilian officials viewed Karzai's move as an
effort to protect those close to him and, in the process, to quash the investigation into
New Ansari.[8][9]

The hawala system is in Afghanistan also instrumental in providing financial services for
the delivery of emergency relief and humanitarian and developmental aid for the majority
of international and domestic NGOs, donor organizations, and development aid agencies.
[10]

On September 1, 2010, the Financial Crimes Enforcement Network issued an advisory on

"Informal Value Transfer Systems".[11]

Hawala scandal
The Hawala scandal or hawala scam was an Indian political scandal involving
payments allegedly received by politicians through hawala brokers, the Jain brothers. It
was a US$18 million bribery scandal that implicated some of the country's leading
politicians. There were also alleged connections with payments being channelled to
Hizbul Mujahideen militants in Kashmir.[1]

Those accused included L. K. Advani, V. C. Shukla, P. Shiv Shankar, Sharad Yadav,

Balram Jakhar, and Madan Lal Khurana. Many were acquitted in 1997 and 1998, partly
because the hawala records (including diaries) were judged in court to be inadequate as
the main evidence.[2] The failure of this prosecution by the Central Bureau of
Investigation was widely criticised.[3]

Hawala CASE IN NEWS

Black money case: Hawala operator Syed
Abbas Naqvi moved funds for Hasan
Ali
NEW DELHI: Syed Abbas Naqvi, a hawala operator from Mumbai, has emerged as a key
player in executing cash transactions of Hasan Ali Khan, the Pune-based businessman
accused of stashing away $8 billion in Swiss banks.

Both Khan and his associate Kashinath Tapuria, the businessman from Kolkata, who too
is incarcerated in jail, during interrogation by the Enforcement Directorate have admitted
to their links with Naqvi. The duo told investigators that they had utilised Naqvi's
services to move large amounts of funds abroad.

The Mumbai-based hawala operator has emerged the key link in Khan's black money
trail. ED is now engaged in probing whether he was involved in 'round-tripping' funds -
siphoning off black money abroad and bringing it back to the country, laundered.

ED believes Khan and people close to him made a fortune by trafficking in money. Their
clients included those who were blacklisted by Swiss banks and hence had to use
accounts of others to divert their funds. They found an ideal conduit in Khan.

ED believes Khan earned huge amounts of money as commission in the process. The
money was brought back into the country either through the hawala network or a
labyrinth of accounts run by the Khan-Tapuria duo and their associates.

One such account was managed by RM Investment and Trading Co, a firm managed by
Tapuria. Enforcement Directorate has detected a diversion of funds into the company
from the Zurich branch of Credit Lyonnais.

Khan and Tapuria, when asked by ED to explain the source of the funds which they had
received from abroad, replied that they had earned it by way of commission for services
rendered to clients. But they failed to explain what these services were.

Khan and Tapuria, according to an ED source, opened a web of accounts to eliminate the
chances of zeroing on their sources. This is a standard practice employed by people
seeking to channelise ill-gotten money.

ED now claims to have sufficient evidence to nail Khan and his accomplices under the
Prevention of Money Laundering Act.
REFERENCES
1. Money Laundering in Insurance business – Ms. B. Padmaja (May 2006)
2. Legal Regime for Anti-money Laundering- Mr. K. P. Krishnan
3. Examples of Money Laundering - IAIS Guidance paper on anti-money laundering
and combating the financing of terrorism (October 2004)
4. Briefing on ‘KYC’ Norms and ‘AML’ Measures for IBA Member Banks – Mr.
Sanjeev Singh (June 2006)
5. Money Laundering: Methods & Markets
6. Suspected Money Laundering in Residential Real Estate – A study by Financial
Crimes Enforcement Network (April 2008)
7. Basics of Anti-Money Laundering & Know Your Customer - M.RAVINDRAN
8. Anti-Money Laundering – Role of Technology – Mr. Vasant Godse (L&T Infotech)
9. The hawala alternative remittance system and its role in money laundering, Interpol
General Secretariat, Lyon, (January 2000) - Mr. Patrick M. Jost - United States
Department of the Treasury, Financial Crimes Enforcement Network (FinCEN) and
Mr. Harjit Singh Sandhu - Interpol/ FOPAC